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  • Writer's pictureMano Chidambaram

Why Real Estate is not an "alternative" asset any more

Updated: Mar 2, 2018

Why every "smart" investor should consider real estate, as an essential component of their overall investment portfolio

Has anyone been watching the stock market lately? Up 2% one day. Down 1% the next. And next week, next month, the same cycle repeats all over again. I am not sure about you, but that is a lot of volatility to stomach for a lot of people.

Despite potential lackluster performance, with increased volatility, most investment portfolios tend to be stock & bond heavy. This is what most people are familiar with. This is what you see marketed on TV, online, in commercials, etc.

This is what J.P. Morgan had to say in, in their research article "Real estate: Alternative no more"

"…investment portfolios focused on the “Big Two Traditionals,” bonds and equities (stocks), are forcing investors to compromise – either by sacrificing return for lower volatility or enhancing return at the expense of higher risk.
Real estate may offer a way out. This is why we believe real estate is increasingly being viewed, not as an alternative, but as an essential portfolio component"

While treasuries & investment-grade bonds offer lower volatility, yields are at historic lows. Bonds also has this inverse relationship between yield and value, i.e., when yields increase values go down

Equities on the other hand may provide a higher return but at an increased volatility.

During the greatest bull market from ‘82 – ’00, the S&P 500, had an inflation-adjusted, annualized return(CAGR) of 14.9%. Since then, the S&P 500 has only returned an inflation adjusted CAGR of 2.3% thru ‘16.

Over the long run, the stock market has had an inflation-adjusted, annualized return of just 6% – 7%

Many high net worth investors are now realizing that alternatives are an important part of a modern investment portfolio. Yale University’s endowment has grown from $4 billion to $25.6 billion over the last 20 years by focusing on alternatives, such as real estate with high expected returns

If you are seeking better returns, you can’t outperform the market by only investing in the market. A portfolio can’t really be considered balanced, until it includes more of the asset classes that produce higher, risk-adjusted returns.

Private real estate investment could offer a potential solution. Real estate offers investors a potential for equity gains in a strong market and downside protection of stable income source via cash flow from operations, in a weak market.

Here are some key reasons on why real estate should not be considered an "alternative" investment no more & should be a part of your portfolio:

Significant market, too big to ignore

The total US real estate investment market is big, $8.2T big, out of which, private real estate investment is more than half at over $4.7T. That is a very large investment universe to ignore. Actually, the wealthy have been investing in real estate for a very long time to build generational wealth.

As you can see from this picture, investors have multiple ways of investing in this space, some through traditional vehicles like REIT's in the public market, & others through the private market

Provides, stable, bond like yields with equity like appreciation

The yields offered by real estate are very attractive compared to less risky instruments like investment grade bonds. To get similar level of yields as real estate, one would have to move into much riskier high-yield bonds

The other thing to keep in mind is that these yields for stabilized property are relatively stable over time. Tenants often tend to lock in rental leases over multiple years with potential rent increases built into their leases. A diversified portfolio across different asset types, geographies & tenants across different industries will tend to stagger lease renewals across time, thus offering further stability in the income stream.

Since commercial real estate value is based on the net income generated, as rent goes up over time, the value of the asset increases thus providing equity like gains at the time of sale.

So, if you always thought that real estate was not for you, there is a strong argument to be made for why real estate should be considered an essential component of your investment portfolio.

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